How to roll over your 401(k)

LAST REVIEWED Oct 22 2021 10 MIN READ

By Damian Davila

The U.S. Bureau of Labor Statistics found that 2.9% of Americans—that’s 4.3 million people—quit their jobs in August 2021, a record-breaking month that has been preceded by similar statistic-shattering months that year. What’s been coined the “Great Resignation,” this phenomena has been triggered by several factors, including the pandemic and the rise of remote work. These “pandemic epiphanies” have caused workers to reconsider their priorities in life, often resulting in a reshuffling of careers.

If you're one of millions of workers who's changed—or is considering changing—jobs, it's important to make the most of any retirement savings you may have. Knowing how to roll over your 401(k) is an essential step to maximize your nest egg. From understanding how vesting works to knowing the required steps to do an indirect rollover, we'll review how to roll over a 401(k) after leaving an employer.

Step 1: Find out your fully vested account balance

When you check the account balance of your 401(k) online or on a paper statement, you may not be looking at the amount that you would take with you if you were to quit, be fired, or laid off today. While your personal pre-tax or post-tax contributions are always fully vested, matching contributions and profit sharing contributions from your employer may be subject to a vesting schedule.

Take a look at the provisions of your 401(k) plan regarding employer contributions, because they may state that if you leave within a certain period of time, you’ll lose some of the proceeds. Under a cliff vesting schedule, employer contributions only become fully vested after a minimum number of years. Under a graded vesting schedule, employer contributions are gradually vested over time.

If you have a dispute about 401(k) vesting with your employer, contact the Employee Benefits Security Administration (EBSA) for assistance.

Step 2: Take stock of unpaid loans from your 401(k)

Here’s another reason why it doesn’t always make sense to take a loan from your 401(k). If your plan allows you to take a loan, you’ll generally have up to five years to pay the loan back in full. Participants have until tax day of the following year to repay outstanding loans on their 401(k). For example, if you are terminated in April 2020, you have until April 15, 2021 to repay a loan.

In the event you’re unable to pay back the remaining balance, it becomes an early distribution, triggering income taxes and, if under age 59 1/2, a 10% penalty from the IRS. Some states may charge additional income taxes and penalties. And you can’t roll over unpaid loans to an IRA or 401(k), effectively reducing your nest egg.

This is why when doing a cost-benefit analysis of accepting a new job offer, make sure to include the cost of losing a non-vested portion and paying income taxes (and penalties if applicable) on early distributions of your nest egg.

Leaving the money in your old 401(k) can work against you

Even when you part ways with your employer in the best possible terms and are very happy with your old 401(k) plan’s rules and fees, not rolling over your vested balance to a new retirement account can work against you in many ways:

  • You can no longer contribute to your former employer’s 401(k). 

  • If your 401(k) balance is less than $1,000, your employer has the option of cashing out your account and mail you a check minus mandatory 20% percent withholding. This may trigger additional tax penalties at the federal, state, and local levels.

  • If your vested balance is more than $1,000, your former employer must transfer the money to an IRA.

  • After separation from employment, over half of 401(k) plans with balances between $1,000 and $5,000 are forcefully transferred to an IRA.

  • Forced-transfer IRAs have typical investment returns ranging from 0.01% to 2.05% annually, which barely cover applicable fees.

If you’re concerned about company securities, including stocks, bonds or debentures that would be subject to income tax when withdrawn from your old 401(k), consult your plan administrator or financial advisor for tax scenarios to defer tax payment on the appreciation of those company securities.

You can still roll over cash outs from a 401(k)

Don’t spend that check! If you spend a $900 cash out instead of rolling it over into an account earning 8% tax-deferred earnings, your retirement fund could end up with more than $9,000 after 30 years*. The bigger your cash out you spend, the higher your opportunity cost.

If you’re able to find a new employer offering you a 401(k) or IRA, or you open a new retirement account that accepts the cash out check within 60 days from your last day of employment, then take advantage of an indirect rollover to recoup withholding and avoid paying penalties.

You’ll have to deposit the entire check and come up with the 20% that your employer withheld. By completing an indirect rollover within the time limit, the IRS will refund the entire withholding in your next tax return.

Step 3: Do the math

When evaluating 401(k)s and IRAS, consider the following:

Roth IRA IRA401(k)
Maximum contribution for 2021$6,000$6,000$19,500
Maximum catch-up contribution for age 50+ for 2021$1,000 $1,000 $6,500
Tax deductible contributionsNoYes, if you qualify Yes
Required minimum distributions can be delayed beyond age 72YesNoYes, if working
Taxes at time of rolloverYesNoNo
Options for early distributions without penaltySeveralSeveralSeveral
Protection from claims by creditorsOnly in bankruptcyOnly in bankruptcyYes
Limit on rollovers per yearOneOneNone

For a full comparison of these plans see: 401(k) vs IRA: How to Decide

It’s key to figure out how much you’re currently paying in fees and expenses for your 401(k). Use that number to determine how much more or less in fees and expenses you would pay under the new plan. While you have no control on actual returns, you can always control actual expenses!

Step 4: Do a direct rollover to a 401(k) or IRA

This is the most cost-effective way to do a 401(k) rollover. A direct rollover empowers you to choose a retirement account that best suits your needs, minimize plan fees, maximize potential returns, and continue growing your money tax-deferred.

No matter what is the retirement account of your choice, check with your new plan administrator whether or not your 401(k) balance is eligible for a rollover. Physical checks for rollovers are still mailed via snail mail and selecting an ineligible plan recipient could cause you to miss the window to complete a direct rollover.

Some additional steps:

  • Check with your current 401(k) provider to see if they accept incoming rollovers, and whether this will result in any fees. If they do accept rollovers, they should give you some information about what to ask your previous 401(k) provider for in terms of paperwork and information.

  • Notify your previous 401(k) provider that you’d like to withdraw/roll over your fund to a new 401(k). Keep in mind that they will probably not make this process easy, quick, or cheap (there may be a withdrawal fee) as they have no financial incentive to make it easy for you to leave (i.e., lose you as a client).

Each provider is different, but make sure to ask these questions, at the very minimum:

  • Current provider: To whom should the check be made payable? What is the account number? What is the address to which the check should be mailed?

  • Previous provider: Is there a withdrawal fee? Will you be mailing me the check, or can you mail it directly to my new 401(k) provider (or their custodial bank) on my behalf? Will you send me a 1099-R form via email or mail? Is my contact information up-to-date in your system?

IRS Form 1099-R acts as a receipt to show that your money was rolled over and not withdrawn. Once it’s sent to you, you should file it when you do your taxes as proof that the money was rolled over, so that you won’t have to pay taxes on this transaction.

Start your 401(k) rollover today

Be patient with the rollover process and don’t be surprised if you may have to jump on the phone a couple of times with your former and new plan administrators. Focus on the retirement account that is best suited for your long-term retirement saving plans and not on the one offering the least amount of paperwork.

Start your 401(k) rollover today with a consultation with Human Interest. We’re here to provide you the resources you need to save the way you deserve.

Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.

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Notes

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*Using a compound interest calculator, $900 growing at 8% over 30 years would equal $9,056.39 (note: this calculation does not account for administrative fees or other costs).